Fitch Ratings has affirmed Darden Restaurants, Inc.'s ratings, including its Long-Term Issuer Default Rating (IDR) at 'BBB' and its Short-Term Rating at 'F2'.

Fitch has also assigned a 'BBB' rating to Darden's $500 million senior notes issuance. Net proceeds from notes offering, along with cash on hand, will be used to repay Darden's $600 million term loan. The Rating Outlook is Stable.

The 'BBB' rating reflects Darden's sizable revenue base of roughly $11 billion proforma for the acquisition of Ruth's Hospitality Group, Inc., its strong free cash flow and liquidity, its disciplined financial policy and its proven ability to outperform the broader casual dining segment which has been experiencing secular pressure. While a potential moderation in discretionary spending could adversely impact Darden's operating performance, Fitch's current expectations for moderate EBITDAR leverage, based on Fitch adjustments, in the mid 2x area provides ratings headroom.

Key Rating Drivers

Key Drivers Stable Recent Performance: Darden's revenue in fiscal 2023 (ended May 28) experienced growth of 8.9% driven by strong same store sales growth and addition of new restaurants. Fiscal 2023 gross margins declined around 90 bps compared to fiscal 2022 reflecting commodity and labor inflation in the 1H of fiscal 2023 and its pricing strategy to maintain its value proposition. As a result, EBITDA margins declined to 14.9%, around 100bps lower from 2022 levels with EBITDA, based on Fitch adjustments, of $1.56 billion, a modest increase from 2022 level of $1.53 billion.

In fiscal 2024, Fitch projects revenue increasing around 10% driven by organic growth of around 5% and by the acquisition of Ruth's of about 5%. Fitch projects gross margin could improve moderately as the company experiences deflation in categories such as chicken, seafood and dairy helping offset inflation in beef, wheat and other categories. Additionally, Fitch expects labor inflation could be managed by improving productivity. Fitch expects EBITDA margin to be around relatively flat in fiscal 2024 with EBITDA of $1.74 billion.

Casual Dining Segment Facing Secular Challenges: Modest overall growth across the sector highlights challenges the casual dining segment has faced over the past decade, including share losses stemming from the rapid growth of the fast-casual segment of the restaurant market, given the perceived convenience, value and quality of the offering.

Additionally, the full-service restaurant store base has grown in the low-single digits since 2010, contributing to an oversaturation in the market. Fitch expects that Darden's scale, expertise and resources will allow it to continue to invest in areas such as menu innovation, cost savings, technology and customer experience that will continue to drive market share gains as smaller peers are less equipped to manage these challenges.

Bolt-on Fine Dining Acquisition: Darden recently completed the acquisition of Ruth's Chris steakhouse in June 2023 for a total consideration of $725 million funded through a new $600 million term loan along with cash on hand. The acquisition brings meaningful scale with around $500 million in revenues and about $75 million of EBITDA that increases Darden's exposure to fine dining category. Historically, Darden has demonstrated the ability to integrate acquisitions and derive meaningful synergies.

Darden expects to realize net run-rate synergies of about $25 million as it aims to leverage its scale and supplier network. Ruth's steakhouse operates a combination of franchise-based and company-owned restaurants versus Darden which primarily operates company-owned restaurants.

SRS Recovers Despite Weak Traffic: Darden's same-restaurant sales (SRS) continue to outperform that of its peers, enabling the company to benefit from economies of scale and improve profitability. According to the company, SRS growth at Olive Garden and LongHorn Steakhouse outpaced respective industry benchmarks in fiscal 2023, continuing a strong rebound from the pandemic driven by core menu enhancements and good restaurant execution.

While Darden's sales have recovered from depressed levels during the pandemic, traffic on a year-over- year basis has softened. Weaker traffic, however, has been offset by strong ticket which has benefited from price increases and reduced discounting. Fitch expects SRS sales in fiscal 2024 to be at the lower end of the company's guidance of 2.5%- 3% given Fitch's view around discretionary consumer spending which could pressure industry sales. Beyond fiscal 2024, SRS growth is expected to be around 1% - 1.5% range.

Moderate Leverage: Following the acquisition of Ruth's steakhouse in June 2023, proforma EBITDAR leverage for fiscal 2023 based on Fitch's adjustments was around 2.5x. This compares to EBITDAR leverage of 2.4x in fiscal 2022. Fitch expects leverage will be managed over time within the company's 2.0x-2.5x target (capitalizing minimum rent payments at 6x).Fitch's adjusted leverage is roughly 0.5x higher than the company's adjusted leverage due to the differences in lease adjustments. Fitch expects Darden's longer-term EBITDAR leverage to be around 2.5x barring material debt financed acquisitions, on a Fitch-adjusted basis.

Strong FCF: FCF has averaged over $300 million annually since fiscal 2019, despite turning negative in fiscal 2020 due to the pandemic. The company's dividend has increased with EBITDA growth, with around $640 million in dividends expected in fiscal 2024 compared to $371 million in fiscal 2019 (pre-pandemic). Fitch expects FCF of around $350 million in fiscal 2024. Thereafter, Fitch expects FCF in the range of $350 million to $400 million annually and expects the company will use FCF for share repurchases and tuck in acquisitions.

Derivation Summary

Darden's 'BBB' rating reflects it sizable revenue base of roughly $11 billion proforma for the Ruth's acquisition, its strong free cash flow and liquidity, the disciplined financial policy and its proven ability to outperform the broader casual dining segment which has been experiencing secular pressure. While a potential moderation in discretionary spending could adversely impact Darden's operating performance, expectations for moderate EBITDAR leverage, based on Fitch adjustments, in the mid 2x area provides headroom at the current ratings.

Similarly rated peers in the retail and consumer products industries include Sysco, Campbell Soup Company, and Bacardi.

Campbell's 'BBB'/Rating Watch Negative (RWN) ratings reflect its strong brands, significant market share in several product categories, solid profit margins and consistent FCF generation. Fitch expects EBITDA leverage to be in the mid-2x in fiscal 2023 (ended July). Fitch expects organic sales to be flat to modestly positive over the medium with EBITDA sustained at around $1.7 billion to $1.8 billion for the standalone business over the medium term. The RWN reflects the potential increase for a sustained increase in leverage, pro forma for the Sovos transaction.

Bacardi's 'BBB-/Stable' ratings reflect a strong competitive position supported by good diversification in more than 160 markets worldwide and healthy profitability with leading premium and super-premium brands that have strong market share across several spirit categories. The acquisition of Patron enhanced Bacardi's portfolio and materially increased exposure to the super-premium plus Tequila category, which is one of the fastest growing spirits categories in the U.S. Fitch expects Bacardi to manage EBITDA leverage during the next couple of years toward the low 3x area absent material M&A reflecting the company's net leverage target of 3.0x.

Sysco's 'BBB'/Stable rating reflects the company's large scale, good market position, and diverse customer base with broad geographical distribution of an extensive line of food and non-food items including Sysco-branded products with an estimated 17% share of the U.S. foodservice market. Fitch expects Sysco will demonstrate consistent capital allocation priorities by investing in the business including bolt-on M&A and returning value to shareholders with EBITDAR leverage expected in the low 3x range

Key Assumptions

Revenues are expected to increase by 10% in fiscal 2024 to around $11.5 billion driven by a combination of acquisition growth, low single digit SRS growth and around 50 new restaurant openings. Revenues thereafter are expected to grow in the low single digit range;

Fitch expects EBITDA to improve modestly in fiscal 2024 and EBITDA margins roughly flat in fiscal 2024 as commodity inflation eases;

FCF after dividends of around $350 million in fiscal 2024.Fitch expects the company will use free cash flow for share repurchases and/or acquisitions;

EBITDAR leverage to be around 2.5x barring material debt financed acquisitions;

The majority of Darden's capital structure has fixed rate debt with no maturities until 2027. The company has exposure to variable rates through the CP program. As of Aug, 27, 2023, $95.4 million of commercial paper was outstanding.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

A public commitment to maintain lease-adjusted leverage at the low end of the company's 2.0x to 2.5x target (based on capitalizing rent expense at 6x minimum rents) which roughly equates to Fitch's EBITDAR leverage calculation of 2.5x to 3x such that EBITDAR leverage is sustained below 2.5x;

Continued market share gains with positive SRS and positive traffic performance.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A change in financial strategy such that EBITDAR leverage is sustained above 3.0x due to significantly higher debt;

Persistent SRS and operating earnings decline or market share loss, particularly at Olive Garden and LongHorn Steakhouse.

Liquidity and Debt Structure

Solid Liquidity: As of Aug. 27, 2023, Darden had $192.1 million (net of $48.4 million in restricted cash) of cash and $904.6 million availability on its $1 billion revolver due September 2026 given $95.4 million of commercial paper was outstanding. The company has $939 million of senior unsecured notes outstanding with the earliest maturity $500 million of 3.85% notes due May 2027. In addition, the company has a $600 million senior unsecured term loan facility due 2026. Net proceeds from notes offering, along with cash on hand, will be used to repay Darden's $600 million term loan.

Issuer Profile

Darden Restaurants, Inc. is the largest full-service restaurant companies in the U.S. with more than 2,000 restaurants across brands including Olive Garden, LongHorn Steakhouse, Cheddar's Scratch Kitchen, Ruth's Chris Steak House, Yard House, The Capital Grille, Seasons 52, Bahama Breeze, Eddie V's and The Capital Burger.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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